Case Analysis 4

On

“ABBOTT LABS SUFFERS CREDIT DOWNGRADE IN WAKE

OF TAKEOVER OF ST. JUDE’S MEDICAL”

SOM 650 - Mergers, Acquisitions and Business Valuation

Shailesh J. Mehta School of Management, IIT Bombay

Submitted by-

Group 6
Kshitij Joshi – 209278057
Peri Sai Teja – 209278062
Pushpak Suhas Dronkar – 209278073
Rohit Kumar – 209278070
Sarath Santhosh – 209278066
Saurabh Pandey – 209278069
Q1. What is the form of payment and form of acquisition used in this transaction? Speculate
as to why they were these chosen?
Answer.
Abbott used a combination of cash and stock to finance the acquisition. A significant part of
the acquisition ($10 B) was paid in stock as the total payment ($23.6 B) was too high to be
financed alone by cash. Receiving $13.6 B in cash would have enabled St. Jude to pay taxes
on any existing tax liability
The form of acquisition in this case is purchase of stock. It was chosen because by controlling
such many shares of the target company, the acquirer wins the rights on assets and
intellectual property of the target. This was needed to make progress in the knowledge-based
heart device industry.

Q2. What are positive (or affirmation) and negative covenants? How can such covenants
affect Abbott’s future investment decisions? Be specific.
Answer.
A covenant is a formal agreement of debt, or a promise in an indenture that certain thresholds
will have to be met and certain activities will or will not be carried out. Borrowers make these
promises to lenders. When a contract is broken, the lender has the right to demand prompt
repayment of any outstanding loans, however most lenders give the borrower a grace period
to correct the problem.
An affirmative covenant is a type of contract or agreement that requires a party to follow
certain specific terms. Affirmative covenants bind an issuer to do certain activities or satisfy
specific standards, such as maintaining a specific credit rating, delivering audited financial
performance reports in accordance with GAAP, and adhering to the law.
A negative covenant is a contract that forbids a corporation from doing specific things.
Negative covenants can be used in a variety of situations, including limiting the amount of
new borrowing that can be done and requiring the borrower to adhere to a minimum interest
coverage ratio.
Considering Abbott is already facing a displeasure of investors about the acquisition of Jude
Medical, covenants can limit the ability of Abbott to pursue what it believes are attractive
future investment opportunities by prohibiting additional borrowing to finance new spending.
Q3. The deal is taxable to St. Jude shareholders to the extent that they realize a gain. The
reason is that the reverse triangular merger structure used in this instance does not qualify
as a tax-free merger. Why?
Answer.
In a reverse triangular merger, a new company is formed as a subsidiary of the acquiring
company which purchases the target company, and the subsidiary is then absorbed with the
target company.
Section 368 of the Internal Revenue Code lists the factors to be considered for the merger to
be taxable.
“A reverse triangular merger may qualify as a tax-free reorganization when 80% of the seller’s
stock is acquired with the voting stock of the buyer; the non-stock consideration may not
exceed 20% of the total.”
This means that at least 80% of the payment to St. Jude’s shareholders must be in the form
of Abbott stock. But since only about 42% of the payment is in the form of Abbott stock (the
rest was in the form of cash), the deal could not be qualified as tax free.

Q4. What is a bridge loan? What does it mean that they were unsecured? The terms of these
bridge loans were to automatically terminate no later than July 27, 2017, at which point
Abbott was to have its permanent long-term financing in place. What is “permanent
financing?” Explain your answer.
Answer.
Bridge Loans: It is a short-term loan intended to help a person or corporation get permanent
financing or pay off an obligation. It provides the user with quick cash flow, allowing them to
meet their present obligations. These loans are short-term that last up to a year, with high
interest rates, and are typically backed by some sort of collateral such as real estate or
inventory.
Unsecured loan: In Abbots' situation, however, the bridge loan had no collateral. As a result,
the loans were unsecured. Because of abbot's size, volume of business with its lenders, and
reputation, they were able to acquire unsecured (no collateral) bridging loans. The bridge loan
facility had two tranches: a $15.2 billion 364-day unsecured bridge term loan and a $2 billion
120-day unsecured bridge term loan, according to the negotiated terms and conditions. The
bridge loans were set to expire on July 27, 2017, at which point Abbott was expected to have
secured permanent long-term finance.
Permanent Financing: Bridge loans help bridge the gap between when money is needed but
not yet available. Bridge loans are used by both businesses and individuals, and lenders can
tailor them to fit a variety of needs. A long-term loan that can be categorised as long-term
debt or equity financing is known as permanent financing. A third-party provides money to
borrowers in long-term debt financing to allow them to buy certain assets or fund a certain
project. The borrower will have to put the company's assets on the line in exchange for the
monies they give. In the case of equity financing, the lender may be given a portion of the
company's ownership, allowing business owners to rest certain that they will have the
finances they need to succeed. Aside from the methods described above, Abbott raised extra
funds through selling assets. Abbott and St. Jude Medical agreed to sell certain goods to
Terumo Corporation for $1.12 billion in 2016, with the transaction closing on January 20,
2017.

Q5. The merger is characterized as a reverse triangular merger. Speculate as to why this
structure may have been chosen? Explain your answer.
Answer.
A reverse triangular merger refers to the formation of a new organization, when an acquiring
organization first creates a subsidiary, the subsidiary purchases the target company, and the
said subsidiary is then absorbed by the target company. It is more easily accomplished, since
subsidiary has only one shareholder – i.e., the acquiring company, who can obtain the control
of target firm’s non-transferable assets and contracts.
The structure may have been chosen since a reverse triangular merger eliminates the
requirement shareholder approval for parent firm, since the parent is the sole shareholder in
the Merger Sub. The target firm can retain any non-assignable franchise, lease, or other
contract rights, as the same survives. The acquirer avoids accelerating the repayment of loans
outstanding by not dissolving the target.

Q6. Abbott could have directly merged with St. Jude. Why was a wholly owned merger sub
created by Abbott to own St. Jude’s assets and liabilities instead? Explain your answer.
Answer.
Abbot limits its exposure to any potential liabilities in case any of the firm’s medical devices
fail by keeping St. Jude as a wholly owned subsidiary. The cost of any such liability is now
limited to the extent of Abbott's investment in St. Jude
The target company was purchased by a subsidiary created by Abbott (Merger Sub) and then
this subsidiary was absorbed by the target company. This helps the acquiring company obtain
control of the targets non-transferable assets and this type of merger is easy to implement.
Apart from that, this also allowed the company to sell some of their assets to Terumo
Corporation and raise additional cash. It helped to avoid any negative impact of the merged
entity on the current relationships with customers and creditors.